Photo Credit: Jason Wesley Upton || Of course this isn't China...

Photo Credit: Jason Wesley Upton || Of course this isn’t China…

I know this is redacted, but it is advice to a reader in a really remote area of the world.  You might find it interesting.

I am currently with the XXX team in XXX.  We are taking about trying to budget the [project] with the inflation of the past months being 50%. And September being 91%. I think XXX would appreciate your thoughts on the likely economic and inflation situation. They are trying to decide whether to move to working on dollars. And how to budget if they stay in the [local currency].

Dear [Friend],

One question that may not matter so much… is the inflation rate 50-91%/year, or 50-91%/month?  The reason I ask this is if that is the rate per month, then you should try to do as much business as you can in dollars, and/or treat the local currency like a hot potato… don’t hold onto it long – it is not a store of value.  It is normal in such a situation for another currency to become the practical currency when inflation gets that high… even if it is illegal.

If the rate is 50-91%/year, that’s not great to work with, but prices are still moving slow enough for you to have some degree of a planning horizon in the local currency.  Still, any big transactions should be done in dollars, unless you are certain that you are getting a favorable rate in the local currency.

As for budgeting, it could be useful to do the budget in both currencies.  This will help to raise the natural question of what happens if you don’t have the right currency.  Here’s what I mean: ask what currencies you would naturally use to transact to accomplish your goals – look at both revenues and expenses.  If you find your expenses are mainly in dollars or euros, but revenues are in the local currency, you will need to do one of two things.  Either a) try to charge in hard currency terms, or raise revenue rates regularly, or b) build in a significant pad in local currency terms for the things you would typically buy in a hard currency.

Feel free to send me a spreadsheet on this.  As an aside, you can tell XXX that I have little trust that the situation will improve rapidly.  The government is too corrupt, its budget way out of balance, and any revenue from oil is down.  It would take a hero willing to end the corruption, and then survive ending it, in order for the inflation to stop.

In closing, the following paragraph is illustrative, and not strictly relevant:

I realize that you all aren’t investing in the country, but if you were, I would give the following advice: invest in land.  In a nation where there are no securities market, and the government is the cause of the inflation, land is the only thing that retains value.  AIG used to do this all the time in countries, particularly when they couldn’t remit their earnings there back to the US.  As they say in Argentina, “The wealthy preserve their wealth by owning land.”  So long as land is not expropriated, it protects wealth against governments who steal via inflation.  Gold is similar, but where you are, something that light and valuable could easily be stolen.

Anyway, I missed you at XXX, and hope and pray that you are doing well.  If you or anyone else on the team has questions on this, just let me know.  I’ll make time for you.

In Christ,


A while ago I wrote two pieces called “Easy In, Hard Out.”  The main idea was to illustrate the difficulties that the Federal Reserve will face in removing policy accommodation.   In the past, the greater the easing cycle, the harder the tightening cycle.  I don’t think this time will be any different.

In the last two pieces, I showed three graphs to illustrate how the Fed’s balance sheet has changed.  I’m going to show them again now, updated to 11/11/2015.  Here’s the graph showing the liabilities of the Federal Reserve — i.e. what the Fed eventually has to pay back, occasionally with interest:

I’ve added a new category since last time — reverse repurchase agreements (“reverse repos”) because it has gotten big.  In that category, you have money market funds (etc.) lending to the Fed to pick up a pittance in interest.

As you might note — as the balance sheet has grown, all categories of liabilities have grown.  The pristine balance sheet composed mostly of currency is no more — it is only around 30% of the liabilities now.  The biggest increase in reserve balances at the Fed — banks lending to the Fed to receive a pittance in interest, because they have nothing better to do for now.

I’ve considered doing an experiment, and I might do it over the next few weeks.  I went to my copy of AAII Stock Investor, and pulled out the contact data for 336 banks with market capitalizations of over $100 million.  I was thinking of calling 10 of them at random, and asking the following questions:

  • What has the Fed’s ZIRP policy done to your business?
  • Do you have a lot of money on deposit at the Federal Reserve?
  • When the Fed raises the short-term interest rate, what do you plan on doing?
  • Then, the same questions asking them about their competitors.
  • Finally, who has the most to lose in this situation?

It could be revealing, or it could be a zonk.

One more interesting note: reverse repos and my “all other” category have become increasingly volatile of late.

Here’s my next graph, with the asset class composition of the Fed’s balance sheet:

The Fed has gone from a pristine balance sheet of 95% Treasuries to one of 60/40 Treasuries and Mortgage-backed securities [MBS].  MBS are considerably less liquid than Treasuries, particularly when you are the largest holder of them by a wide margin — I’ve heard that it is 25% of the market.  The moment that it would become public knowledge that you were a seller, the market would re-rate down in price considerably, until holders became compensated for the risk of more MBS supply.

Finally, here is the maturity graph for the assets owned by the Fed:

The pristine balance sheet of 2008 was very short in its interest rate sensitivity for its assets — maybe 3 years average at most.  Now maybe the average maturity is 12?  I think it is longer…

Does anybody remember when I wrote a series of very unpopular pieces back in 2008 defending mark-to-market accounting?  Those made me very unpopular inside Finacorp, the now-defunct firm I worked for back then.

I see three hands raised.  My, how time flies.  For the three of you, do you remember what the toxic balance sheet combination is?  The one lady is raising her hand.  The lady has it right — Illiquid assets and liquid liabilities!

In a minor way, that is the Fed now.  Their liabilities will reprice little as they raise rates, while the market value of their assets will fall harder if the yield curve moves in a parallel shift.  No guarantee of a parallel shift, though — and I think the long end may not budge, as in 2004-7.  Either way though, the income of the Fed will decline rapidly, and any adjustment to their balance sheet will prove difficult to achieve.

What’s that, you say?  The Fed doesn’t mark its assets to market?  You got it.  But cash flows don’t change as a result of accounting.

Now, there is one bit of complexity here that was rumored at the Cato Conference — supposedly the Fed doesn’t use a prepayment model with its MBS.  If anyone has better info on that, let me know.  If true, the average life figures which are mostly in the 10-30 years bucket are highly suspect.

As a result of the no-mark-to-market accounting, the Fed won’t show deterioration of its balance sheet in any conventional way.  But you could see seigniorage — the excess interest paid to the US Treasury go negative, and the dividend to its owner banks suspended/delayed for a time if rates rose enough.  Asking the banks to buy more stock in the Federal Reserve would also be a possibility if things got bad enough — i.e., where the future cash flows from the assets could never pay all of the liabilities.  (Yes, they could print money together with the Treasury, but that has issues of its own.  Everything the Fed has done with credit so far has been sterile.  No helicopter drop of money yet.)

Of course, if interest rates rose that much, the US Treasury’s future deficits would balloon, and there would be a lot of political pressure to keep interest rates low if possible.  Remember, central banks are political creatures, much as their independence is advertised.


Ugh.  The conclusions of my last two pieces were nuanced.  This one is not.  My main point is this: even with the great powers that a central bank has, the next tightening cycle has ample reason for large negative surprises, leading to a premature end of the tightening cycle, and more muddling thereafter, or possibly, some scenario that the Treasury and Fed can’t control.

Be ready, and take some risk off the table.

Blogging a whole conference can be an exhausting affair.  Two things I did not expect — sitting in on the press conference with Lacker and Bullard, and blogging the Lunch speaker from the BIS [Bank of International Settlements].

There were a lot of themes that went around.  I’ll try to highlight a few of them, and add my own thoughts.

What is the proper mandate for the Central Bank?

The representatives from the Fed generally thought the dual mandate worked well.  Most of the critics favored a single mandate of preserving purchasing power of currency, and no mandate of full employment.  The reasoning varied there, but as Plosser commented, a dual mandate is what gives the Fed wiggle room to not be rules based, but discretionary.  Others commented that the ability of the Fed to affect labor issues is poor.

Plosser also told us to consider the actual text of the dual mandate:

“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”

He said it was interesting how it focused on monetary and credit aggregates as the tools to affect employment, prices, and long interest rates.  I had to admit when I heard that, that the dual mandate is better and worse than I thought.  Better because it focuses on money and credit as a unit.  Worse, because it gives the Fed three disparate targets, and the Fed is bad enough in trying to hit stable prices.  It doesn’t need distractions.

Beyond that, most agreed that adding even more targets for monetary policy was a really bad idea — effects on foreign countries, level of the currency, etc.

That said, Borio of the BIS suggested that monetary policy might be better off with a single mandate focusing on growth of liabilities to avoid financial crises, because financial crises cut economic growth severely.  This is closer to the way that I think.  The Fed should adopt a goal of modesty, and merely try to avoid messing things up, as they did with the flood of liquidity prior to the Great Depression, and in 2003-7.

Aiming for a moderate growth in total liabilities would probably be a better version of Friedman’s idea of a constant growth in M2.

Rules vs Discretion

This one was more agreed.  Most favored a more rules-based monetary policy.  As noted above, the main argument was over what the rule should be.

Central Bank Independence

There are two questions on Central Bank independence.  The first is what are they independent from, and the second is whether they are competent.  Over both of those is a question of accountability.  Ultimately, they are a creature of Congress, and should be directly accountable to Congress.

As I have pointed out before, the Fed protests actions that compromise their independence, while taking actions to serve the political ends of those they favor.  Put more simply, the Federal Reserve, like many nonprofits, is managed for the good of the management of the Federal Reserve.  They do that which maximizes their power and resources, subject to risk constraints.  This isn’t too surprising — most bureaucracies behave that way.

Are things normal or broken?  Did the Fed rescue us, or create a bigger crisis to come?

The Fed governors and a few economists felt that things are mostly normal, while most of the rest felt that things are broken, and a greater crisis could come.

What crises could we face?  There are the simple ones, like sending the emerging markets through the shredder.  Many noted at the conference how the monetary policy of the big nations travels to the smaller nations under a system of floating exchange rates.

Another possibility is with residential mortgage bonds limited to a few coupons — negative convexity is potentially high.  Tightening, if it led to a rise in long rates, could be like 1994, one of the worst years the bond market faced.

More likely is that deflation continues, and the Fed reinforces it with more QE.  All of the Fed’s forecasts have erred on the side of rapid growth that has not materialized.  As it is, with demand growth limited, we continue to bump along the bottom with ZIRP, with the Fed’s balance sheet growing bit by bit.

What will happen when Fed tightens?

Maybe not much.  Maybe too much.  It will be interesting to see how how banks and money market funds react to slightly higher rates.  I lean toward the “maybe not much” if/when they tighten.  I’m still not convinced that the Fed will tighten, simply because they have let a lot of little mini-crises derail them from what could be a more important task — that of normalizing the yield curve.  What will go “boo” next week?

Four Final Notes

  1. The Fed should not do fiscal policy, or quasi-fiscal policy.  The Fed is less effective at its main task of monetary policy because they go after areas outside the core of what they have to do: buying MBS rather than Treasuries only, buying long Treasuries rather than short Treasuries, and being a financial & systemic risk regulator.  A monetary policy that is not aggressive will avoid systemic risk… but the Fed went too far many times in easing policy, and not far enough in tightening policy when it was needed.
  2. The session on the “knowledge problem” was interesting and right, but it is basically the problem that any bureaucrat runs into.  So long as you have regulation, the knowledge problem will exist.  That said, you didn’t need to have this session at a monetary policy conference, because the problem is not unique to monetary policy.
  3. Hilsenrath took up an argument of mine about the Fed — it is an intellectual monoculture of neoclassical economists.  Lacker argued that neoclassical economists often disagree with each other, so it’s not a problem.  It *is* a problem, though, because the methods don’t lead to good forecasts, and thus good policy.
  4. I think the Fed needs to revisit their models, and think more broadly — labor use is getting affected by demographics, technology and global trade.  These factors aren’t going away, and they are resulting in a permanent reduction in opportunities for the lesser-skilled areas of the workforces in the developed world, until the whole capitalist world is developed, and wage rates finish equalizing globally.

What should the Fed expect?  Its ideas are flawed at their core as the world has changed, and closed-economy macroeconomics don’t apply well.  Their efforts to change tinker at the edges, and don’t realize their tools aren’t effective.  Better to set modest goals for monetary policy of a stable price level with no debt bubbles.  That is achievable, and it is better to do what you can do well, than attempt things beyond your ability.

Photo Credit: DonkeyHotey

Photo Credit: DonkeyHotey

Rep. Bill Huizenga
Chairman, House Subcommittee on Monetary Policy and Trade

Suggested FSOC is a tool of the Fed to press fiscal agenda.  60 new regulations, thousands of pages.

High degree of discretion… Fed makes it up as it goes, like Jazz.

Government knows best is not  what is best for the economy as a whole.

The dual mandate allows the Fed to do things that go outside of what would be a strict monetary mandate — and what it can ultimately affect.

His bill HR 3189 will likely pass the House in the next few weeks, and then will head over to the Senate (where who knows will happen to it).

Aims to increase transparency and accountability of the Fed, and give more weight to the regional presidents.  How large the audits would be is open.  Emergency lending powers would be reduced.  Five of seven governors and nine of twelve regional Fed Presidents would have to approve any emergency lending.

Fed would have to take a rules based strategy for monetary policy.


1) David Malpass: Would the bill change IOER?


2) Any audit of the IOER?

Not at present.

3) — goes into article 1.10 of the Constitution to have the states insist on commodity money — gold and silver?

How do we get back to a gold standard?  How could we educate the public on its value?  Would back money with a basket of commodities.

4) Torres of Bloomberg: what if the Fed buys more assets in another recession years from now?

Would lead to frustration.  The Fed should not be in that business.  Thinks many politicians are hypocritical because they tell the Fed what to do, and yet he gets accused of meddling with central bank independence.

5) Moderator notes that Elizabeth Warren wants to limit emergency lending — any chance for bipartisanship?

Quite possible, but banks will oppose it.

6) Alex Pollock: Sen. Shelby’s bill — how do you see his bill?

He doesn’t know enough to say, but he wants to get his bill through the House.

7) wouldn’t the Fed getting heavier regulation crash the equity markets?

This isn’t a question of that, everyone should have the same information and access to credit.

8) Can we keep Alexander Hamilton on the $10?

There are efforts to do that….

9) Buchanan suggested a monetary rule that would be in the Constitution?

They aren’t prescribing a rule.  Only holding them to a rule that the Fed itself would specify.

10) What of the Senate Bill, and how will you work with it?

Speaker Ryan is handling the House well.  We would like to do this on a bipartisan basis.

11) What to do with all of the reserves held at the Fed? Seiniorage?

Happy to take money away from Congress.

Photo Credit: European Parliament

Photo Credit: European Parliament


Moderator: Craig Torres
Reporter, Bloomberg

Jerry L. Jordan
Former President, Federal Reserve Bank of Cleveland

Lawrence H. White
Professor of Economics, George Mason University

Kevin Dowd
Professor of Finance and Economics, Durham University

Torres introduces White, who talks about the need for a Fed exit from credit policy

QE was not a monetary policy.  M2 anemic amid a huge rise in the monetary base.  High powered money ain’t.  Did not want to see M2 rise, which would lead to inflation.

Fed sterilized through interest on excess reserves [IOER].  This favored housing over other uses of credit.  Fiscal policy masquerading as monetary policy.

Dramatic impact on its portfolio duration and income.  Record interest income.  Most gets gets rebated to the Treasury, rest to the banks.  Thinks Fed’s average maturity has moved from 4 to 12 years.  Buiter predicted it.  Fed is doing it all for the Treasury.

Fed shouldn’t allocate credit.  Takes away Congress’s job of wasting money. [DM: he said it, not me]  Now a demand comes for a Puerto Rico bailout.  Can’t give away money costlessly, even if you print it.

Lowers penalty for failure.  At present the Fed has no plans to exit credit allocation; Congress will have to act to end it.

Jerry Jordan: Fed built the financial bubble.  13th Fed res bank?  Think he’s talking about Fannie and Freddie…

Monetary authorities as eunuchs.  Political Viagra needed.  Has fiat money run its course?

Foreign banks borrowing from the FHLB.

Money multipliers broken, high powered money does not exist.  Central bank balance sheet is unrelated to money conditions in the economy.  QE can be contractionary.  There is no possible exit from QE.  Stopping QE was good, but ending it will not happen, because IOER and reverse repos are the rule.  IOER borrows from banks and RR borrows from money market funds and GSEs.

Zero experience on IOER and Rev repos.  Who knows what would happen if inflation rose?

Conclusion: aggressive Fed policy has had no impact on inflation, and the Fed does not truly affect credit at present.  Thee are no tools now for dealing with a rise in inflation.

Torres: things are anything but normal now.

Dowd: Extreme Keynesian Policies have not delivered.

Hi recommendation: Recommoditize the dollar, recapitalize the bank, restore strong governance to banking, and roll back government intervention

?? Put Hetty Green on the $10 bill!

Commodity standards with a feedback rule. [DM: quack, quack]

Banks need to run with high levels of capital in order to take more risks.  Higher standards, and less gameable.  Riskier positions would be penalized.

Banks would not be able to pay bonuses, dividends, buy back stock until they were compliant.  SIFI banks only at 7% GAAP capital, 5% under IFRS.  Social consequences of higher bank capital levels are zero.  Capital is not a “rainy day fund.” [True]

Bank directors would be limited to unlimited personal liabilities.  Bring back double liability for shareholders?  Unlimited liabiity for shareholders.  Look at the investment banks; when they went public, they threw risk control away.

GSEs and Fed  would be wound down.  Oligarchy of bankers block reform.  Take the crony out of capitalism.


1) High capital requirements but deregulating — what are you proposing? Depositors will seek highest return, and create another type of moral hazard.

D: Aims for getting the government out of the economy.

2) Bert Ely: possibility for capital arbitrage?  Also shadow banking?

D: Capital rules created capital arbitrage.

Another fellow suggested that banks would be entirely equity funded.

3) Question on abolishing cash?

D: Deflationary collapse.

4) What would happen if people were taxed for holding cash?

Much held by foreigners — punish them with negative interest rates.  But it will never happen.

5) To Larry: what of negative interest rates.  Wouldn’t assets still stay at the Fed for regulatory reasons?

W: ??

6) Transition from monetary to fiscal policy at the Fed?

Bernanke’s theory was that housing had to be preserved above all else.  Same thing for long term rates.  Debt service costs to Treasuries reduced.

7) Wouldn’t negative interest rates destroy GDP?

Yes. then asked about whether there were any bond investors.  Asked what would happen if the Fed tried to sell its mortgages.

Answer from one manager: I wouldn’t want to be the first buyer, and I wouldn’t trust the actions of the Fed… so the market and prices would back up considerably.


Photo Credit: Zach Copley


Moderator: George Melloan
Former Deputy Editor, Wall Street Journal

Gerald P. O’Driscoll Jr.
Senior Fellow, Cato Institute

Alex J. Pollock
Resident Fellow, American Enterprise Institute

David Malpass
President, Encima Global LLC

Melloan introduces Gerald P. O’Driscoll Jr.

The Knowledge Problem — Hayek argued that knowledge is dispersed — impossible to aggregate it without incentives.  What everyone knows is more than what regulators know.  There is no way that a central planner (or banker) could know what the right answer is for economics.  As such, socialism morphed to become social democracy.  USSR collapsed.

Rules encapsulate important knowledge gained by society over time, which enables actors to have a better idea of what to do.  Disclosure reduces fraud.

Monetary policy discretion gives too much power to a small group of men.

Pollock says that the Fed does not know what it is doing, and can’t know what it is doing.  The problem is too complex, and the knowledge to get and interpret to too hard.  Fed biggest SIFI of all, and creates more systemic risk than anyone.  The Fed as a result has not done well in the past, and is unlikely to do so in the future.

Financial instability was not destroyed by the Fed; experts are often given to aggressive actions from bad theories.  Faith in experts is a secular religious problem.

Prices quintupling in a lifetime is considered price stability.

“The Fed must be independent.” But if the Fed is not competent, then should it be independent?  How and to whom should the Fed be accountable.  No part of a democratic government should be unaccountable.  The Fed must be responsible to Congress.  That said, the Fed has often been a useful lapdog to the Congress… funding deficits, etc.  Congress in 1963 agreed with this idea at the 50th anniversary of the Fed.

Humphrey Hawkins does not help accountability.  Financial Accountability Improvement Bill — FOMC would have to make detailed reports to the Congress, including dissenting opinions.

Banking committees in both houses captured by the housing industry.

Calls for a joint committee on the Federal Reserve; should also be able to audit the Fed in any way appropriate.

“The money question” affects so many things that it needs to be broadly discussed.

David Malpass — Post-monetarism: the Fed’s Growth Options

Negative effects of Fed policy on the economy.  Fed is huge and distortive.

ECB — buy anything at any time.

ZIRP will weigh on growth for decades.

Post-monetarism — direct regulation of the financial system.  Monetary and credit policies merged.  Credit growth is slower as a result.  Required bank reserves have fallen and are rising now.  No transmission of M0 into other aggregates.  Fed buys long bonds and advantages them — benefits government and corporations.

Core capex orders are weak.  Employment to population ratio at a low, forget the unemployment rate.  Median household income is declining — increased inequality.

Fed has four options to boost growth:

a) move rates above the zero bound.  Aids savers and would be a loosening of credit.  Maybe the interbank laon market would increase.

b) taper reinvestment, and free up Treasuries for liquidity and collateral.  Fed assets at $4.5T.  Banks assets currently at Fed.

c) Increase repo borrowing.  Fed Liabs at $4.4T.  More credit gets pushed out to banks.  Would be more idle cash to lend.

d) Fed has a severe bunching of maturing assets in the short run.  Presently would invest maturing assets long.  Should the Fed own long duration assets?

Q&A — 1) no one has the interests of everyone else at heart.  Central bankers have poor incentives — they maximize for themselves

O’D: even with good motives, they can’t get it right

M: Quis Custodes Custodiet.

2) Freedom: gold can’t be counterfeited, debased, maximize freedom.

P: American dollar good as gold — Bretton Woods.  Silver Certificates were repudiated.



Photo Credit: Adam Baker

Photo Credit: Adam Baker


Claudio Borio
Head, Monetary and Economic Department, Bank for International Settlements  [praised by the Economist and others]

1) How do we view equilibrium?

How can we tell if market rates are at an equilibrium or not?  Inflation as disequilibrium or financial imbalances?

Monetary policy affects credit and growth.  Output deviations are short-term, financial cycles are longer term 16-20 years.

Rates should be near what the equilibrium rate should be. [DM: how do you know that rate?]

2) Monetary neutrality — Financial crises create permanent losses of GDP.  Debt overhangs, resource misallocation:

  • Financial booms overcome productivity growth
  • Labor gets reallocated to lower productivity areas
  • Sectoral misallocation of resources — 6% of GDP lost

Allocation, not total amount of credit is key.  Blancesheet reform and structural reforms.  Macroeconomic models need to move beyond one simple benchmark.

3) Deflation can be good or bad — deflation is not always bad for output — the link between deflation and growth is weak, and nonexistent without the Great Depression

No evidence of Fisherian debt deflation, but property prices react to private debt levels. [DM: not sure what he is going for here]

Supply driven deflations are good, demand driven bad.

Thus move away from deflation to avoiding financial crises.

4) Different view of the fall in real rates — Global rise in debt, and rates go lower because it is difficult to incent people to take on more debt.

Low rates in one place can influence behavior elsewhere — thus the recent increase in external dollar liabilities.  Also, low interest rates globally.

5) Early warnings of banking distress — if we focus on financial crises, how do you craft policy?

If you use credit measures — can get a better view of GDP

Macroprudential policy operates in a similar way.

Focusing on financial crises would neglect inflation.

His conclusion is that a monetary focus on financial stability will lead to the best growth in GDP.

1990s a disequilibrium situation, with asymmetric monetary policy leading to an explosion in debts.

Quotes Twain on what you know that just ain’t so is that which hurts you.

Q&A 1) Tavlas — low inflation makes it difficult to get out of debt. Eurozone deficit nations can’t regain competitiveness, can’t reduce wages enough.

B: You make good points, but asset prices matter highly — we need to look at those.

2) Selgin — if productivity-driven, it will not be deflationary.

B: repair is slow; monetary policy could not do much to fix a financial crisis

3) Real time, difficult to tell whether supply or demand-driven.

B: Booms and busts would be reduced if we did this.

Photo Credit: Day Donaldson

Photo Credit: Day Donaldson


Moderator: Jeffrey A. Miron
Senior Lecturer, Harvard University, and Senior Fellow, Cato Institute

Charles I. Plosser
Former President and CEO, Federal Reserve Bank of Philadelphia

John B. Taylor
Mary and Robert Raymond Professor of Economics, Stanford University

George A. Selgin
Director, Cato Center for Monetary and Financial Alternatives

Scott B. Sumner
Director, Program on Monetary Policy, Mercatus Center, George Mason University


Missed Plosser.

Got here in time to hear Taylor. Mentions the effects of non-rule-based monetary policy.  Notes how capital controls are being tolerated more and more.  More and more volatility in financial markets.

Mentions how he called the change in 2003-5, and how QE is essentially anti-rule in its application.  “QE begets QE.”

Central banks follow each other more and more.  Rules based policy is not impossible per se.  If more nations were to follow them, you could get a global economy that is rule based.

“Rule-based policy begets rule-based policy.” Would not threaten independence of Central Banks.

Selgin — Real & Pseudo Monetary Rules [playing off Friedman Real and Pseudo Gold Standard]

Should rule out capricious monetary policy a la Venezuela — avoid political influence.  Could allow for a more timely policy than discretion might achieve.  Rules aid credibility.

Rules are no good if they aren’t followed and enforced.  Robust rules would not lead to regret.

Pegged exchanged rate is a pseudo-rule.  Audit the Fed has weak rules and enforcement/consequences.

A psuedo rule could be worse than discretion.  When the rule breaks there could be negative results.

Suggests that a contractual rule provides sanctions.  Nonadherence to a standard leads to losses.  Monetary policy via government promises versus private contract will fail, promises will be broken.

If monetary instruments are targets, easy to achieve, but may not do good for the economy.  Feedback rules could be the best.  Long and variable lags will apply.

Dollarization, Bitcoin, blah, blah, blah… slight diss of Scot Sumner

Scott Sumner: Nudge the Fed to a rules based, nominal GDP based approach.  Central banks move slow. Three pragmatic reforms:

  1. Define stance of monetary policy — is policy easy or tight?
  2. Make Fed more accountable — revisit past policy ex post
  3. Take small steps toward NGDP targeting.

We don’t clearly know whether policy is truly tight or loose.  What is the right variable?

Interest rates don’t measure the status of monetary policy.  Asset prices showed policy was tight as prices fell in 2008.  Mishkin — NGDP.

NGDP looks at both the supply side and demand side.  Bernanke admitting mistakes [DM: but does not admit anything on the 2000-2005 overexpansion of liquidity].

Asks that the Fed look back over 1-2 years to analyze how monetary policy really was in terms of tightness.  Level targeting within bounds would give guidance to decisions.

NGDP futures market proposed.  [DM: that is a punters market, and won’t work.

Q: to Sumner: NGDP includes govt spending, so it can be gamed.

S: too big too exclude.  Aggregate nominal labor compensation might be better as a target.

Q: David Malpass: what would work better for tight/loose than interest rates?

Taylor: money growth — rules vs not are a more important thing

Q: Bert Ely: Why not let the market dictate policy?

Selgin: that could be gamed.  Fiat money is artificially scarce.  Not sure what you would actually target, feed back, etc.

Q: is the dual mandate a good thing?

Plosser: the dual mandate is important.  Actual text of the dual mandate is important — and it does have its problems, because it creates discretion.

Photo Credit: joiseyshowaa

Photo Credit: joiseyshowaa

Press conference w/Bullard: embargoed until end of talk.  [everything is a paraphrase here, and I can’t get everything down, as with everything at this conference]

Neo-Fisherian ideas are interesting and worthy of further talking about, but don’t take them too seriously.

The longer you are at a zero bound — the neo-Fisherian effects get larger.

Q: new monetary consensus of a low nominal world.  Won’t the abnormal become normal?

B: ECB and Japan still doing QE.  We are now trying to normalize.

Q: Balance sheet. edging up rates?

B: liftoff, then review the balance sheet.  Gradualism will be the normal policy, more shallow than 1994 or 2006.  Won’t have credibility on gradualism until the second move.  More on gradualism — not a constant slope, but state-dependent.

Q: [Bloomberg]  Why go gradually?

B: He has higher dots.  Forecasts lower unemployment.  Need to see how things evolve.

Q: Wan’t it difficult for the Fed to veer from prior policy moves?

B: You have to retain your options, and move accordingly.  Labor markets could tighten considerably.

Q: [Dow Jones] Any concern that you will have unanticipated effects on the ECB and World?

B: No. Those are priced in anyway.

Q: keeping the markets calm?

B: we won’t give a total roadmap, we can’t.  It won’t be like 1994.  We will communicate more.

Q: Chorus of criticism from the GOP?

B: Fed has been in the middle of the action since the crisis.  Adds to a healthy debate on priorities for monetary policy.  What should we have has targets…

Q: Is the FOMC shifting its official inflation measure?  Dallas Fed Trimmed Mean?

B: Trimmed mean is better statistically.  Target should be overall inflation.

Now it is time for Lacker

Jury is still out on how we handled on 2008-9.  Not surprised on the political furor.

Q: What will happen when FOMC raises rates?

L: should be smooth.  News will be in the announcement.  Shouldn’t be a surprise.

Q: ??

L: My dots are above median. Should be a flatter cycle.

Q: Regarding his paper, if the price level is all that matters, why not have the 2% more prominent?

L: Can’t reject the possibility that chance is keeping inflation low, and a slow-moving component.  Communications are pretty clear now.

Q [marketwatch] FOMC behind curve?

L: We might be, we might not.

Q: Possible that Fed won’t be gradual?

L: Possible.  Consider inflation 2003-2004 to 2007, we got behind on inflation.


Q: any reform ideas you might support?

L: IOER given to Board, should go to the FOMC.

Q: should a Taylor rule be mandated?

L: wouldn’t mandate it, we even consider them, and maybe we should discuss why we differ from them.

Q: your view on the balance sheet?

L wind down quickly, if possible.

Q: my question on whether globalization and technology affecting the  labor share and thus monetary policy?

L: models could take account of that if they wanted to — depends what you think the goals of policy are.  If inflation only, a focus on employment might have an effect, or we could end up pursuing pushing for unemployment that we can’t achieve.



Moderator: Jon Hilsenrath
Chief Economics Correspondent, Wall Street Journal

Jeffrey M. Lacker
President and CEO, Federal Reserve Bank of Richmond

George S. Tavlas
Member, Monetary Policy Council, Bank of Greece

Manuel Sánchez
Deputy Governor, Bank of Mexico

Panel starts with Hilsenrath introducing Manuel Sánchez.  Argues that monetary policy should have modest objectives.  Takes a conventional view that some inflation is good, that monetary policy is powerful and can deal with macroeconomic problems.  Favors the lender of last resort powers of the Central Bank a la Bagehot.

Monetary policy can best serve markets by not being distracted from the main goals — low inflation and macroeconomic stability.  If monetary policy gets too many goals, it will not achieve its important goals, and may not truly achieve much useful at all.  After all, look at the loose policy prior to the Great Depression, and possibly loose policy prior to the recent financial crisis.

Current policy may be creating financial imbalances now, and lack of incentive for governments to get their own houses in order.

Emerging economies have their own issues with monetary policy, with many cutting rates (DM: competitive devaluation).  Now many emerging economy central reverse those moves, amid rising risks.

Now George S. Tavlas — should monetary policy be based on rules vs discretion?  Taylor Rule makes monetary policy transparent and predictable.  Failure to follow the Taylor Rule 2003-6 led to the financial crisis.  Bernanke argues for freedom.

Asks what would Milton Friedman would do now?  Depends on which Milton Friedman you talk about, as he was a Keynesian (1946) and became a monetarist.  W/Schwartz in 1948, started writing their book on monetary policy.  Their arguments stemmed from the long run effect, versus a short run effect which could be highly variable.  Argued that the collapse of monetary aggregates in 1929-32 led to the Great Depression, and that a simple rule could prevent stupid policymakers.

Friedman felt that feedback policy rules injected too much judgment and discretion, and model risk.

Yet they would be better than raw discretion.  Arthur Burns, teacher of Friedman in the 50s, former Fed Chair, gave into political pressure.  Tavlas thinks that the performance of monetary policy in 90s would favorably dispose Friedman to a Taylor rule.

Cites what Bernanke said to Friedman at his 90th birthday.  Odd comment on how a rule at U Chicago led to Friedman’s marriage to Rose.

Now Jeffrey M. Lacker, President and CEO, Federal Reserve Bank of Richmond.  Argues that monetary policy is undiminished in its ability to affect the price level in the long term.  Ability to affect real variables is limited and transitory.

Argues on a popular view of resource use a la the Phillips curve — that overuse of resources leads to inflation.

Argues that the zero lower bound does not constrain policy now, but that short rates should rise now.  The existing inflation rates may be overly low for random reasons.

Doesn’t think that the increase in the Fed’s balance sheet has any long-term effect on the economy.

Argues for limited goals for monetary policy.

Q&A 1 — Hilsenrath: talk about monetary policy inflation targets. Gold standard, NGDP, etc., should there be a discussion for a new target on monetary policy?

Lacker — present target works well.  Absent a rule a la Taylor other rules will not work well.  Gold standard does not work well, and does not provide price stability.

Hilsenrath — Asset inflation?

Lacker — that should not be a goal for monetary policy.

Tavlas — gold standard had adjustment methods that worked pre-1914.  Unemployment was not a consideration. Union power in the 20s pushed for employment as a factor in monetary policy, and wages would no longer adjust lower.

Argues that when rates were raised to deal with an incipient asset bubble — great depression.  Eventually said that the CPI was a fine goal.

Sanchez also agrees with a CPI goal.  Says it is difficult to spot bubbles, and they may be due to fiscal policies.

Q2 — Mike Mork,  asks about the drop in velocity of M2.  Why?

Lacker doesn’t know.  (Nice honest answer.)  Increase in currency abroad?

Q3 — Lacker says that non-economists are a good influence on the FOMC and a diversity of views.

Q4 — Hilsenrath — Is there a monoculture of views among Ph.D. economists at the Fed.

Lacker — Economists disagree with each other.

Q5 — Josh Crum — what do you do with people bypassing banks in the future?

Lacker — not sure how what the Fed can or should do on that issue.  Has a lot of thoughts, but not so many conclusions.  Mentions repos and money market funds, and the need for maturity transformation.

Q6 — Hilsenrath — should the ECB do more QE?

Tavlas — ECB thinks they can’t affect real variables, but can affect price inflation.

Hilsenrath — but is it working?

Tavlas — takes time for monetary policy to work.  Should eventually work.

Q7 — David Malpass — will the Fed raising rates be stimulative?

Lacker can’t see stimulus.  Can’t see how credit demand would increase even if supply does.

Q8 — Hilsenrath asks how Fed’s moves may affect Mexican monetary policy

Sanchez — Fed creates volatility, with rising rates peso may devalue, and inflation may rise in Mexico, but we will adjust to conditions as the Mexican economy changes.  They will takes foreign monetary policy into account as it affects inflation.

He thinks they have been lucky so far.

Hilsenrath — how does the global slowdown affect your policy?

Sanchez — can’t avoid taking the Fed into account, they are just too big.